IRS says that interest on home equity loans often still deductible under Tax Cuts and Jobs Act of 2017 by Tim McTaggart
The following does not constitute tax advice, nor legal advice. Please contact me to discuss your particular circumstances or contact your tax and/or legal adviser to discuss your particular circumstances.
Almost a year ago now, on February 21, 2018 in IR-2018-32, the IRS noted that, "...taxpayers in many cases they can continue to deduct interest paid on home equity loans.
Responding to many questions received from taxpayers and tax professionals, the IRS said that despite newly-enacted restrictions on home mortgages, tax payers can often still deduct interest on a home equity loan, home equity line of credit (HELOC) or second mortgage regardless of how the loan is labelled. The Tax Cuts and Jobs Act of 2017, enacted Dec. 22, suspends from 2018 until 2016 the deduction for interest paid on home equity loans and lines of credit, unless they are used to buy, build or substantially improve the taxpayer's home that secures the loan."
This was very helpful guidance from the IRS regarding its position pertaining to the Tax Cuts impact on mortgage interest deductibility. I have previously posted with an emphasis on the HELOC product but note that the IRS has shown flexibility to include second mortgages and home equity loans, as well as being instruments potentially still qualifying for a mortgage interest deduction.
The IRS further delineated the differences between the new law and the prior law with respect to mortgage interest deduction related to home equity loans and HELOCs. Specifically, the IRS noted, "Under the new law, for example, interest on a home equity loan used to build an addition to an existing home is typically deductible, while interest on the same loan used to pay personal living expenses, such as credit card debts, is not. As under prior law, the loan must be secured by the taxpayer's main home or second home (known as a qualified residence), not exceed the cost of the home and meet other requirements."
The IRS then goes on to note the new dollar limit on total qualified residence loan balance. Specifically, the IRS noted, "For anyone considering taking out a mortgage, the new law imposes a lower dollar limit on mortgages qualifying for the home mortgage interest deduction." The IRS goes on to explain, "Beginning in 2018, taxpayers may only deduct interest on $750,000 of qualified residence loans. The limit is $375,000 for a married taxpayer filing a separate return. These are down from the prior limits of $1 million, or $500,000 for a married taxpayer filing a separate return."
The IRS additionally notes that, "the limits apply to the combined amount of loans used to buy, build or substantially improve the taxpayer's main home and second home." Interestingly, the IRS does not comment on the prior law limit of $100,000 maximum level for mortgage interest deductions for home equity loans and HELOCs. So, generally, the mortgage interest deduction is viewed as tightening up under the new law but for those taxpayers who already have paid off their mortgage or are well below a mortgage indebtedness level of $750,000, the new law may provide more flexibility because it no longer restricts the interest deductibility to home equity loans and HELOCs up to $100,000. Rather the combined amount of a first and second mortgage may not exceed $750,000 for a joint return. Without a $100,000 cap, a taxpayer could have home equity loans or HELOCS of greater than $100,000 provided that the combined first and second mortgage amount remained below the $750,000 level for a joint return.
The IRS then provides examples to illustrate the points that it presented in the February 21, 2018 communication. This blog entry will only look at the first example today and the other two examples will be the topic of future blog postings. So, with respect to Example 1, the IRS noted, "In January 2018, a taxpayer takes out a $500,000 mortgage to purchase a main house with a fair market value of $800,000. In February 2018, the taxpayer takes out a $250,000 home equity loan to put an addition on the main home. Both loans are secured by the main home and the total does not exceed the cost of the home. Because the total amount of both loans does not exceed $750,000, all of the interest paid on the loans is deductible. However, if the taxpayer used the home equity loan proceeds for personal expenses, such as paying off student loans and credit cards, then the interest on the home equity loan would not be deductible."
This example makes clear that under the new law, personal expenses will not deductible any longer with the use of home equity loan proceeds. It also confirms the ability to deduct mortgage indebtedness of a qualified residence subject to restrictions that were in place under prior law. The example also goes through a "limit case" scenario of a joint return taxpayer qualifying at the full $750,000 maximum level.
In sum, as noted in a prior blog posting, banks and others involved with mortgage indebtedness need to be very careful in their specific and general statements concerning the deductibility of mortgage debt under the new Tax law. There also are potential legal, regulatory and compliance issues in connection with the administrative process for these products under the new Tax law. Consultation with counsel and consultants is imperative for institutions with home equity loan portfolios or HELOC portfolios.
Tim McTaggart